The Federal Energy Regulatory Commission (FERC) stunned officials of Duke Energy and Progress Energy on Thursday when it refused to unconditionally approve a $13.7 billion merger deal of the two companies that would have created the largest U.S. electric utility. The regulatory body cited concerns about the merger’s impact on power markets in North and South Carolina—where both companies are based—for its decision.

FERC had conditionally approved the proposed merger on Sept. 30, but it asked the companies to provide a “mitigation proposal” to address adverse effects on competition. The order found that Duke and Progress had “failed the market power screens” established in FERC’s 1996 Merger Policy Statement” because their “post-merger market power concentration in the Carolinas would rise to unacceptable levels.” This was a concern filed, as Raleigh newspaper the News Observer noted, by two small eastern North Carolina cities, Rocky Mount and New Bern, which claimed the merger plan would harm their ability to buy power in a competitive market.

To gain the regulator’s final approval, Duke Energy had on Oct. 17 filed a “virtual divestiture” under which the utility proposed to make between 225 MW and 500 MW of Available Economic Capacity in certain seasons for a period of eight years. But on Thursday, FERC held that that mitigation plan was flawed and did not demonstrate a remedy for identified market power screen failures.

“The mitigation proposal does not eliminate the opportunity for the merged company to act anti-competitively. Although Duke and Progress describe the proposal as a virtual divestiture, it would not transfer control of the energy the applicants propose to sell from the merged company,” FERC said.

“The decision to reject the proposed mitigation plan was not taken lightly,” said FERC Commissioner Cheryl LaFleur. “Given the high levels of market concentration, as measured by the companies’ HHI indices and the Commission’s Delivered Price Test, we remain concerned that the proposed merger will affect the companies’ ability to exercise market power.”

Thursday’s order does “not reject the merger,” FERC clarified, adding the companies may offer another mitigation proposal. In a related order, FERC also rejected the companies’ joint dispatch agreement and joint open access transmission tariff, a “rejection is without prejudice to the applicants re-filing.”

In a joint statement, Duke and Progress said they were committed to proceeding with their planned merger, saying they planned to submit a new mitigation proposal. But they said the merger would be delayed: "The FERC’s action changes the companies’ timeline for closing the merger. The earliest close date would be in March, but will ultimately depend upon the regulatory approval process. The companies are evaluating the regulatory calendar and will communicate a new target close date for planning purposes in the near future.”

According to the two companies, “the FERC ruling does not call into question the benefits of the merger. The combination of Duke Energy and Progress Energy will provide clear benefits for our customers, including overall lower corporate costs and $650 million in guaranteed benefits to customers in the Carolinas from the joint dispatch of the utilities’ generation fleets and from power plant fuel savings."

The companies have so far secured approvals from the U.S. Department of Justice, the Nuclear Regulatory Commission, the Federal Communications Commission, and the Kentucky Public Service Commission.

Sources: POWERnews, FERC, The News Observer, Duke Energy, Progress Energy